Have You Received Student-Loan Forgiveness? Plan Now to Avoid a Tax Bomb
- Miguel Virgen, PhD Student in Business
- Apr 3
- 3 min read
April (Doctors In Business Journal) - If you are one of the many borrowers who had their student loans canceled or reduced under the Biden administration in 2024, congratulations! This relief can significantly ease your financial burden. However, while federal law currently exempts forgiven student loans from taxation, you may still face a hefty tax bill at the state level. In fact, 19 states could tax your forgiven debt as income, creating a potential tax bomb that you need to prepare for now.
In this comprehensive guide, we’ll walk you through what you need to know about student-loan forgiveness taxation, how to determine if you owe state taxes, and strategies to mitigate the impact of a surprise tax bill.
Understanding the Tax Implications of Student-Loan Forgiveness
Federal Tax Exemption for Canceled Student Debt: Under the American Rescue Plan Act of 2021, most forgiven student loans remain tax-free at the federal level through 2025. This means that if you had loans forgiven under the Biden administration’s initiatives in 2024, you won’t owe federal income tax on the forgiven amount. This exemption applies to:
Public Service Loan Forgiveness (PSLF)
Income-Driven Repayment (IDR) forgiveness
One-time student debt cancellation programs
Other federal relief programs
While this is a major relief, state tax laws vary significantly, and some states may consider your forgiven loans taxable income.
Which States May Tax Your Forgiven Student Loans?
As of 2024, 19 states have not aligned their tax codes with federal exemptions for student-loan forgiveness. This means that if you reside in one of these states, your canceled debt could be considered taxable income, potentially increasing your state tax bill by thousands of dollars. The states that may impose taxes on forgiven student loans include: Arkansas, California, Indiana, Minnesota, Mississippi, North Carolina, Wisconsin. Tax rates vary, but some states impose rates as high as 9% or more on taxable income. This means that if you had $20,000 in student debt forgiven, you could owe up to $1,800 in state taxes depending on where you live.
How to Determine If You Owe State Taxes on Forgiven Debt
To find out whether you’ll owe taxes on your forgiven student loans, take these steps:
Check Your State’s Tax Policy: Visit your state’s Department of Revenue website or consult a tax professional to confirm if your forgiven debt is taxable.Review Your State’s Income Tax Rate: Understanding your state’s tax bracket will help you estimate the potential tax liability.
Determine the Forgiven Loan Amount: The total amount of debt relief you received will be the basis for your taxable income calculation.
Consult a Tax Professional: A CPA or tax preparer can help you navigate the specifics of your state’s tax treatment of student-loan forgiveness.
Strategies to Avoid or Reduce a State Tax Bomb
If you discover that you’ll owe state taxes on your forgiven loans, don’t panic. There are several strategies you can use to minimize or prepare for the financial impact.
Adjust Your Withholding or Estimated Tax Payments: If you’re employed, you may be able to adjust your state tax withholding on your paycheck to account for the additional taxable income. If you’re self-employed, consider making estimated tax payments to avoid a large bill at tax time.
Take Advantage of State Tax Deductions and Credits: Some states offer deductions or tax credits that can offset part of your tax burden. Check if your state provides any relief programs for student-loan borrowers. If you expect to owe taxes, setting aside money in advance can prevent financial strain. Consider using a high-yield savings account to earn some interest while you save for your tax payment.
Check for Payment Plans or Hardship Options: Many states allow taxpayers to set up installment plans if they can’t pay their tax bill in full. Contact your state’s tax agency early to explore your options. If your state taxes student-loan forgiveness, consider contacting your state legislators to push for policy changes. Some states have already moved to exempt forgiven student debt from taxation due to public pressure. By planning ahead, you can avoid a tax bomb and ensure that your student-loan relief truly benefits your financial future.
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